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What Are Target-Date Mutual Funds?

Ray Hawk
Ray Hawk

Target-date mutual funds are a type of investment mechanism similar to life-cycle funds that attempt to gauge risk for the investor on a predetermined time-scale as retirement approaches. That is, such investments typically start off with a larger percentage of high risk securities like stock as part of the fund, and gradually these are replaced by safer, conservative investment mediums that can reliably produce a more steady income stream, like bonds, as the investor approaches retirement age. The target-date mutual fund has a preset maturation date like a certificate of deposit (CD), when it is assumed that the investor will sell the fund, and they are meant to be essentially management free. Such mutual funds appeal to investors who don't want to spend the time to continually reevaluate the portfolio mix of their investments and change it year by year as they approach retirement age.

The popular interest in target-date mutual funds skyrocketed between the year 2000 and 2008, with those on the US market rising from total holdings of $8,000,000,000 US Dollars (USD) at the time to $169,000,000,000 USD. This growth was largely fueled by companies with 401(k) retirement plans where the employees did not want to take an active role in determining the mix of investments upon which their plan was based. As of 2011, however, target-date mutual funds have largely fallen out of favor in the investment community. Like many investments targeted towards a one-size-fits-all market where the investors don't want to take an active management role, they often display negative performance results.

Stocks and bonds are mixed into every target-date mutual fund.
Stocks and bonds are mixed into every target-date mutual fund.

Among the major disadvantages to using target-date mutual funds as a form of long-term investment are the facts that the allocation of risk and adjustment of that risk over time are not something that the individual investor can change. Stocks and bonds are also mixed into every target-date mutual fund, which makes optimizing assets for tax purposes impossible. As well, the automatic adjustments in the portfolio mix for target-date funds tends to cut short gains made in good investments and prolong losses in bad ones that make up the fund mix.

Some employers have offered target-date mutual funds to their employees with the false understanding that they were a virtually guaranteed source of income and growth. This perception allowed companies to automatically enroll their employees in the funds when they didn't vocally ask for control over their retirement plan asset mix. As of 2010, however, some of the most prominent target-date mutual funds were showing losses in value as high as 40%.

Despite their loss of widespread popularity, however, target-date mutual funds still offer certain advantages that brought them to prominence in the first place. This includes the fact that they often have low management fees as compared to other mutual funds which are more aggressively traded by active management teams. They offer a wide range of investments, and, if the set retirement age for the fund is many years out, they can have a yearly adjustment in the risk of the asset mix that is only a 1% change, known as the glide path. The most appropriate market for target-date mutual funds appears to be for investors with decades before retirement, which evens out fluctuations in the market year to year. They also seem ideally suited to individual investors who don't have a lot to invest, with minimum investment levels as of 2011 set at $2,500 USD, and low transaction fees to buy into them.

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    • Stocks and bonds are mixed into every target-date mutual fund.
      By: xy
      Stocks and bonds are mixed into every target-date mutual fund.